Tharp's Thoughts Weekly Newsletter (View On-Line)
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Market Update for the Period ending May 31st, 2011
Market Condition: Neutral Normal
I always say that people do not trade the markets; they trade their beliefs about the markets. In that same way, I'd like to point out that these updates reflect my beliefs. If my beliefs and your beliefs are not the same, you may not find them useful. I find the market update information useful for my trading, so I do the work each month and am happy to share that information with my readers.
If your beliefs are not similar to mine, then this information may not be useful to you. Thus, if you are inclined to perform some sort of intellectual exercise to prove one of my beliefs wrong, simply remember that everyone can usually find lots of evidence to support their beliefs and refute others. Know that I acknowledge that these are my beliefs and that your beliefs may be different.
These monthly updates are in the first issue of Tharp's Thoughts each month. This allows us to get the closing month's data. These updates cover 1) the market type (first mentioned in the April 30, 2008 edition of Tharp's Thoughts), 2) the five week status on each of the major US stock market indices, 3) our four star inflation-deflation model plus John Williams' statistics, and 4) tracking the dollar. Beginning this month, I will now report on the strongest and weakest areas of the overall market as a separate SQN® Report. And that may come out twice a month if there are significant market charges.
Part I: Van's Commentary—The Big Picture
Qualitative Easing II (QE2) is due to end next month and that could be the end of the current bull market. However, right now it’s roaring and those items that tend to prosper during inflation—Gold, Silver, Oil, Commodities—are doing the best. That is the big picture in a nutshell. It’s that simple. If and when the Federal Reserve stops printing money like crazy, the stock market rise will stop. Notice what happens in June and be aware.
Part II: The Current Stock Market Type Is Now Neutral Normal
Each month I look at the SQN score for the daily percent changes over 200, 100, 50 and 25 days. On May 26th, the SQN scores for various time frames were all over the place. The 200 day was strong bull, the 100 day was neutral, the 50 day was bullish, and the 25 day was bearish. I’ve never seen four readings that were so diverse. The graph below shows a chart of the SQN 100 calculation over the last year.
The next graph shows market volatility over the last year.
You can see that we’ve now moved into neutral territory. I’m not too worried about that because volatility is just out of the quiet range. However, be cautious this month if prices keep moving down and volatility picks up. Overall the market has grown weaker throughout 2011.
Jason Goepfert’s Sentiment newsletter suggests that dumb money is 50% confident whereas smart money is 46% confident. He believes this is a moderate warning signal for a market downturn. These numbers are not that risky.
Here are the performance figures for the three major US indices over the last month.
| Weekly Changes for the Three Major Stock Indices
|Year to Date
All of them were down for three of the four weeks last month, however, all three indices remain slightly up for the year. Still, if you measure your wealth by the performance of these three indices, you are not doing too well relative to other currencies as the dollar is certainly down for this year.
Part III: Our Four Star Inflation-Deflation Model
Here is the data from our four star inflation-deflation model.
We'll now look at the two-month and six-month changes during the last six months to see what our readings have been.
All but one of the measures were higher last month, so unless we have another massive derivatives collapse, we are in an inflationary environment. This inflation could remain subdued, however, unless or until the banks start lending again, and then it could become interesting. Notice the huge change in the price of gold last month!
Shadowstats.com estimates the M3 money growth has only just turned positive. Imagine that—the Fed is printing massive amounts of money but total money growth has just turned positive. We’ve been talking about the reason for it - the St. Louis Federal Reserve still shows that the banks are not multiplying printed money. Furthermore, it’s in a huge downtrend and at 0.74—that’s the lowest I’ve seen it. The graph below puts the numbers into some historical perspective. Notice the sharp downturn that began earlier this year.
This is not a good sign for the economy.
Incidentally, at the end of April we were in a roaring bull market in commodities. Then most of them crashed. The commodity bull was fueled by short covering creating a parabolic move and then it stopped at the end of the month.
Part IV: Tracking the Dollar
The next table shows the US tracking of the dollar index through April.
As I wrote this article, I checked the Fed’s web site to find that it still has not posted any recent data. As a result, we’ll look at a futures chart instead to see what is really going on.
The dollar bounced off a bottom in early May passing its April highs and then started to retreat. Look for the documented Tharp Effect to exert its influence again soon. I go to Europe on the 11th of June, so look for a fall in the dollar starting about then.
If the dollar continues its decline at this point, however, it will be a bit surprising because the Euro looks particularly weak with the debt situation in several European countries. You might have noticed that the commodities fall in early May had little effect on gold. That’s no wonder with weakness in both the dollar and the Euro.
We’re in a secular bear market, which means a long term and dramatic reduction in valuations. Eventually, we can expect to see S&P 500 PE ratios to reach the single digits. Fundamentally, conditions certainly seem to support that trend even though the economy can actually do quite well in some secular bear markets.
Here is what is going on in my opinion. I said much of this last month, but it’s worth repeating.
- The US economy is in a shambles. The debt is so big that the government cannot fix it. It is only a matter of time before it caves in. Expect the government to default on a lot of its contracts, especially social security.
- 2. I’m in a bit of a personal dilemma because I’m supposed to sign up for Medicare. If I don’t sign up within the next few months, then I’ll actually have go through a qualification process at some point. My dilemma is that I actually feel much more secure with private insurance.
- The Federal Reserve is printing massive amounts of money to stimulate the economy, and usually that should work because the banks normally lend out three or more times as much money as they get from the Fed. But right now the rate of lending is at 0.74. The banks are not lending their money; they are putting it into the market…the big banks at least.
- QE II is due to end this month. If there isn’t a QEIII, there is a good chance that the market will start moving down. Is the government willing to let that happen?
- US interest rates are very, very low right now because the government, due to its debt, cannot afford high interest rates (nor can the economy). Low interest rates, the US account deficit and our massive debt have crashed the dollar. Expect things to get even worse because one day the world will not accept the US dollar as the world’s reserve currency.
- While the market is in a strong bull period, the overall gain in the major indices this year has been less than the amount that the dollar has fallen.
- Along with the April 15 federal tax deadline, there’s a cyclical flow of funds from individuals to pension accounts which goes into the markets. That inflow ended in April. May through November are typically cyclical down months for the market.
- In this climate, long term investing does not work. You must be a trader, and you must have your psychology together in order to succeed. Trading is not easy; you need to educate yourself and exercise your discipline.
Once again, it’s my opinion that you should use the information in these monthly updates to discern when to switch trading systems rather than to forecast the market. This is why it’s imperative that you know how your system will perform under various market conditions. If you haven't heard this before or the other ideas mentioned above, read my book Super Trader, which covers these areas and more so you can make money in any kind of market.
Next month I’ll be teaching workshops in Berlin in early July, so R.J. Hixson will write the June update.
Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. There were lots of good opportunities in 2009. Did you make money? If not, then do you understand why not? The refinement of good trading skills doesn't just happen by opening an account and adding money. You probably spent years learning how to perform your current job at a high skill level. Do you expect to perform at the same high level in your trading without similar preparation? Financial market trading is an arena filled with world class competition. Additionally and most importantly, trading requires massive self-work to produce consistent, large profits under multiple market conditions. Prepare yourself to succeed with a deep desire, strong commitment, and the right training. Until the August update, this is Van Tharp.
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I use the System Quality Number ® (SQN ®) score to measure the market performance of countries, currencies, commodities, and various equity sectors in my world model. I use the SQN 100, which calculates the SQN score of the daily percent change for a 100-day period of the various ETFs we follow. Typically, a score over +1.45 is strongly bullish; a score below -0.7 is very weak.
- Green (strongest): Those ETFs with scores that are more than one standard deviation above the mean (about 1/6 of the ETFs scanned).
- Yellow (the next strongest): Those ETFs with scores above the mean up to one standard deviation (about 1/3 of the ETFs scanned).
- Brown (weak): Those ETFs with scores within one standard deviation below the mean (about 1/3 of ETFs scanned).
- Red (very weak): Those ETFs with scores more than one standard deviation below the mean (about 1/6 of the ETFs scanned).
My World Market Model spreadsheet includes most ETFs—including inverse funds—currently available although I include no leveraged ETFs.
World Market Summary
The US market segments are mostly green, but this month they are light green, not the dark green they were two months ago. And some segments, especially the smaller cap stocks, are quite weak. Look at the top center box.
Now compare the US Market segment scores with the rest of the world. Only Switzerland, Belgium, and Spain are showing green for all of the other countries in the model.
There are a few strong industry sectors. The strongest US sectors are consumer staples, food and beverage, biotech, and health care. And right now, the Swiss Franc is the strongest currency.
India keeps getting weaker and it’s now showing a ranking of minus 1.23.
Except for the seemingly persistent downtrend in Indian stocks, no trends have tended to last very long recently, which makes it difficult to hold long term positions under these market conditions.
The next table shows the relative performance of commodities, real estate, and interest rates, plus the strongest and weakest areas of the all of the ETFs.
Gold seems to dominate the commodities sector now after its fall last month. Oil, coal, water, timber, agriculture, livestock, etc. have all fallen quite a bit in the last month.
Most of the bond funds are getting stronger but the best are TIPS and junk bonds. Long term bonds are not doing that well at all.
Notice that healthcare now dominates the list of top ETFs and the other noticeable sector is consumer staples. Both of these sectors are carryovers from last month’s top list. The worst performing funds list is dominated by inverse US funds. The long dollar fund is also on that bottom list as is the India fund. Nuclear energy made the list of worst performing funds, although I’m surprised it has taken this long to show up there.
My Interpretation of What Is Going On
My interpretation of these results remains the same as I previously stated: the Federal Reserve is printing money like crazy and the banks are not lending it. Instead, it’s probably finding its way to the stock market.
We had a commodities market sell off last month and investors are not sure where to put their money for the long term. And although the dollar bottomed last month, the US dollar is now again collapsing faster than the US stock market is going up.
I noticed that one of my coauthors of Safe Strategies for Financial Freedom, Steve Sjuggerud, says that this is one of the best times ever to buy stocks. Some of the big stocks are now selling at single digit PEs and the S&P 500 PE ratio is now below its historical mean. However, some years ago, I dropped that particular investing model because I now believe that bear markets don’t end until the entire index is in the single digit range and dividend yields are around 6%. We are a still long way from that.
This is a market in which to be a trader, not a long term investor. But to be a trader, you MUST know what you are doing.
During the first part of July, I will be teaching the Blueprint Workshop and the Peak Performance 101 Workshop in Berlin, Germany, so R.J. Hixson will write the June update for me.
Until early August, this is Van Tharp.
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Market Type for the All Ordinaries
Q: I’ve just finished reading Dr. Van Tharp's Definitive Guide To Position Sizing and found it to be one of the most interesting and useful trading books I’ve ever read.
In his book, Dr. Tharp talks about 6 different types of markets. I live in Australia and trade stocks on the All Ordinaries.
I was wondering do you have a table for the All Ordinaries similar to the table in the book for the S&P 500? Or could you provide me with a methodology/formula for calculating this so I can determine what markets my system works best in as per the book?
A: You can effectively do what Van does with the S&P in his monthly updates with the All Ordinaries. He simply takes the closing price for a 100 day window and calculates the percentage gain or loss from day to day. That will provide you with a sample from which you can calculate the expectancy or mean, and the standard deviation. This is fairly simple to do an Excel if you can get the data in there in some easy way. Then, for each 100 day period, You can calculate the SQN and track it as it changes. Note, you can also do this for 50 days or 25 days or however many days it seems to make sense to you.
As for volatility, Van uses the 20 day average true range and divides that by the closing price for each day. This gives you the ATR % which Van uses to track market volatility. Rather than the S&P, you could use the All Ordinaries. If you have a very large data set of closing prices for the index, like 20 or 40 years, you can get a strong sense of what the average and standard deviation are which will provide you a historical benchmark against which you can compare volatility today.
Van wrote several articles about this methodology in the spring of 2009. Look here for the article starting with Understanding Market Type starting in May, 2009.
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